Welcome to the new Becker-Posner Blog, maintained by the University of Chicago Law School.

01/06/2013

How Good is the Fiscal Agreement? Becker

Not good at all in my opinion. The biggest defect is the
failure to do much about federal spending, which has grown rapidly since 2000,
especially during the past 4 years, and will continue to grow unless major reforms
are made. Some of the increases in taxes are desirable but many are not, and
the whole set of tax changes will do little to close present and future fiscal
deficits. Most of the reforms in taxation and spending that I advocate in this
piece will not be considered politically feasible because of the power of
special interests. In fighting special interests, however, one needs to be
clear on the desired goals, and that is the spirit motivating my discussion.

The fiscal agreement has very little reform of the basic tax
code. Nothing was done about the many undesirable special exemptions called “corporate welfare”. These include, among many,
employer deductibility of contributions to health care coverage of its employees;
subsides to the oil industry, and subsidies also to alternative sources of
energy, such as solar.

Middle income and rich families mainly take advantage of the
deduction for interest paid on home mortgages that cost about $90 billion in federal
tax revenue in 2012. Although many attempts have been made to provide economic
and social justifications for encouraging home ownership, the arguments and
evidence have been weak.

Charitable contributions are the other major itemized
deduction. That deduction has greater justification because it helps
decentralize charitable giving away from the government. Nevertheless, with
such large fiscal deficits, that deduction should also be restricted. The
fiscal agreement did limit total deductions by couples earning more than $300,000,
but it did not distinguish among deductions, and the limit should apply to all personal income
tax filers.

The optimal income tax structure-if income rather than
consumption remains the basis of taxation- would have a rather flat percentage
tax on a very broad definition of income that eliminates the great majority of
deductions, and incorporates dividends and capital gains into reported income. The
extra tax revenue from increasing marginal tax rates as incomes increase is not worth the social cost in
the form of tax avoidance measures and tax evasion. An element of progressivity
should be introduced through providing an exemption from income taxes for persons
with incomes below a reasonable poverty line.

The tax changes in the fiscal agreement combine higher taxes
on the “rich”, including limits on their itemized deductions, with higher taxes
on capital gains, dividends, and estates. As Posner indicates, all the changes
combined are estimated to bring in only about $600 billion in additional tax
revenue over ten years. This increase is a drop in the bucket when federal
spending is almost $4 trillion per year. Even the $600 billion figure is a
large overestimate of what will be generated in added revenue because it
assumes no changes in behavior on the part of businesses and individuals affected
by higher tax rates. Corporations are likely to adjust to the higher rates by
reducing dividends, taking more of their incomes abroad, and making other
changes that reduce their tax burdens. Individuals facing higher marginal tax
rates will increase their itemized deductions when this helps reduce their tax obligations,
shift their effort and energy from work to untaxed or lower taxed activities,
and take increasing advantage over time of loopholes discovered by tax lawyers
and accountants.

Virtually nothing was done in the compromise on the spending
side-that supposedly is to be taken up in a couple of months. As Posner
indicates, they did continue to extend unemployment benefits to a maximum of 99
weeks. This does not involve a lot of spending, but the extension makes no
sense when employment is growing each month, and when almost 4 million jobs are
going unfilled. Paying compensation for almost two years of unemployment has
contributed to the large number of workers who have been unemployed for over a
year.

Federal spending has increased from about 18% of GDP in 2000
to over 24% at present. A good part of the increase went to spending on social
security, Medicare, and Medicaid, but many other categories of spending
increased as fast or even faster than these entitlements. Adjusted for
inflation, between 2000 and 2011 Medicare grew by over 100% and Medicaid by 83%,
while income security programs grew by over 130%, and defense grew by 86%.
Spending on highways and mass transit, energy, and various other programs also
grew by a lot. So-called discretionary spending as a whole that includes
various domestic programs and defense grew by over 70%.
So even if we exclude entitlements, there are many places to cut federal
spending to help move the country toward the spending situation at the end of
the Clinton presidency. There was no widespread belief then that the federal
government was on a starvation diet.

Of course, it is also crucial to try to rein in the growth
of Medicare and Medicaid since they are so important. Medicaid and related
government health programs are supposed to be for children and parents in poor
families, but the definition of “poor” has expanded beyond a reasonable level,
and should be scaled back.

A mandate for health care coverage can be justified perhaps
as an effort to control free riding, but such a mandate should require only
coverage against health catastrophes, and it should only subsidize the premiums
of poor families. The Affordable Care Act’s mandate, by contrast, requires
extensive coverage, and subsidizes premiums for individuals earning up to 4
times the poverty level.

Medicare can also be reformed in several ways (see the more
extensive discussion of Medicare reform in my blog post on 4/10/11). One important
change would be to increase the fraction of out of pocket spending by the non-poor
elderly receiving medical treatment under Medicare. This fraction is much below
that in Switzerland, a country that generally provides excellent medical care.
Obamacare does little to increase out of pocket expenses, and instead adds a
series of quotas on care and price controls on payments for care.

The over age 65 population is much healthier than when
Medicare started over half a century ago. This suggests that extending Medicare
eligibility to age 67 or 68 from age 65 would not impose major hardships on
persons of these ages, and it would encourage them to make greater use of
private insurance. Of course, to allow older persons to prepare for this change
in eligibility age, it should not go into effect for say 5 years, and could be
phased in after that.

I am not optimistic that the reforms discussed in this piece
or other reforms will be enacted in the near future. The President and
both sides in Congress have inflexible positions. Nor has the media been of
much help in arousing the public since it has concentrated on how to raise
taxes on the so-called rich rather than on tax and spending reforms. Still,
in trying to change the discussion, it is important to show how to reform the
tax code, and the many reasonable ways to cut federal spending.

Comments

You can follow this conversation by subscribing to the comment feed for this post.

Your statement, "Medicaid and related government health programs are supposed to be for children and parents in poor families," implies that you favor taxing singles and the childfree to support pro-natalism and breeding.

Is there an economic justification for producing children at all, when there are lots of willing immigrants potty-trained, educated and ready to work? If not, I consider your statement as one sponsored by the Vatican. Are you angling for a Nobel Prize in Religion?

This is an excellent post, calling attention to earlier times when government programs were designed more sensibly and functioned much more effectively. Back when people carried major medical insurance they still had a stake in their own health care, and it incentivized plausible behaviors. The whole own-your-own-home policy has not panned out, and as sovereignty rights continue to usurp property rights becomes less justifiable by the year. While I also am a fan of the Fair Tax consumption-based initiative, a flat income tax has major appeal. The unchallenged bloat of the federal government, 33% in 12 years as a share of the whole economy, is certainly at the heart of our other problems.

What I do not understand above is the suggestion that employers not be able to deduct the legitimate business expense of employee health care contributions, which are a form of employee compensation. I would agree we should get rid of the perk itself and not let employers have anything to do with their employees' health care, and I would also agree that EMPLOYEES should not be able to get an employer to pay their health care and then not pay income tax on the value of that compensation. In other words, if you're being paid $50k a year plus health insurance, you're really being paid $65k a year or so, and you should pay income tax on that higher amount. I do not think it fair to say however that employers are getting corporate welfare because they write off a legitimate expense that they actually pay.

Great post, but still another example of wide-spread frustration with Congress to do its job responsibly. The forty-year trend of increasing partisan extremism and the 1956 end of Progressive Era reforms in partisan politics guarantees there is nothing the Congress is capable of doing to help itself from slowly destroying the fiscal health of the republic.

Just as the Progressive Era combined center-Rights and center-Lefts to link reform with expanding the state, so a new Freedomist Era would combine center-Lefts and center-Rights to link reform with slowing down the expanding state. But then, whoever said Dr. Becker was center-Right or that he would be interested in the Freedomist Era?

It's common to talk about how reducing deductions would help. I've started to wonder, though, whether maybe we've done a lot in that direction already---- via the AMT. It limits the deduction of state and local taxes. Doesn't it limit the mortgage interest deduction too? On the other hand, it doesn't apply to charitable deductions, or to the invisible health insurance premium deduction.